Sarbox Takes a Constitutional

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By challenging the constitutionality of the Public Company Accounting Oversight Board, plaintiffs in a lawsuit filed last week believe that they can spur the courts and Congress to undo the entire Sarbanes-Oxley Act.

While many federal laws have a “severability” provision that enables Congress to change a section of a law without dismantling it entirely, Sarbanes-Oxley doesn’t, according to Michael Carvin, a lawyer with Jones Day in Washington and lead attorney for the plaintiffs. A successful lawsuit might prompt a “remedy broader than fixing the board,” he adds, and perhaps “force Congress to face the issue” of passing legislation to overhaul Sarbox as a whole.

Indeed, Mallory Factor — chairman of the nonprofit Free Enterprise Fund, which promotes limits on government — acknowledges that the lawsuit is “an attack” on all of Sarbox. In addition to initiating the suit, Factor asserts that the organization has been working with members of the House and Senate on legislation that would do away with the act.

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Some lawyers, however, think it unlikely that the courts would invalidate a law as massive as Sarbanes-Oxley even if the plaintiffs prevail. “Just because one part is unconstitutional doesn’t mean the whole is,” maintains Thomas Sjoblom of Chadbourne Parke, who argued — unsuccessfully — against the constitutionality of Sarbox during his defense of former HealthSouth Corp. chief executive officer Richard Scrushy. “They’re not going to throw out the whole act of Congress.”

To be sure, the lawsuit — filed on February 7 in U.S. District Court for the District of Columbia against the PCAOB and its four individual members — addresses only Title I of Sarbanes-Oxley, the provision that governs the accounting oversight board.

Title I established the PCAOB as a corporate nonprofit that’s “not an agency or establishment of the United States government.” The litigation disputes that contention; despite the law’s “effort to characterize the board as a private corporation, the board is a government entity subject to the limits of the United States Constitution,” the lawsuit argues. Citing Sen. Phil Gramm (R-Tex.), a supporter of Sarbanes-Oxley who nonetheless took note of the board’s “massive unchecked powers,” the plaintiffs also point to the PCAOB’s “broad discretion to set policy and impose regulations governing the conduct of public accounting firms.”

For their part, the board and its lawyers are still studying the suit and aren’t yet prepared to respond to questions about its merits, says Christi Harlan, director of public affairs at the PCAOB. “But they do intend to vigorously defend the board’s right to do the work that was assigned to it by the Congress and President Bush,” she adds.

Specifically, the plaintiffs assert that the setup of the PCAOB violates the separation of powers principal under the Constitution as well as its appointments clause. In both regards, the lawsuit contends, problems arise because members of the Securities and Exchange Commission — and not anyone from the executive, legislative, or judicial branches of government — appoint the PCAOB’s members.

The board’s reporting structure violates the separation-of-powers principle under Article II of the Constitution, the lawsuit contends, because “the board’s wide-ranging exercise of executive or administrative power is immune from presidential supervision or control.” The lawsuit, which notes that the PCAOB is not named by or removable by the President, also cites the Article II provisions stating that “executive power shall be vested in the President” and “he shall take care that the laws be faithfully executed.”

The PCAOB’s tasks amount to “an executive function being performed by no one in the executive branch,” contends Garvin. “There’s literally no accountability, no checks and balances.”

As for the appointments clause, which also appears under Article II, the lawsuit observes that the President is empowered to name ambassadors, cabinet ministers, “and all other officers” of the nation, with the advice and consent of the Senate. An “inferior officer” of the United States must be appointed by the President, a court, or the head of a federal agency.

The SEC strikes out on three counts, according to Hans Bader, an attorney with the Competitive Enterprise Institute who helped draft the lawsuit. Bader maintains that the PCAOB would need to show that its members are “inferior officers,” that the SEC is a “department” of the federal government, and that the five commissioners of the SEC collectively amount to a department head.

Bader argues, first, that the PCAOB members’ can’t be considered inferior officers — which could be appointed by a department head — because they exert too much power. Since they can levy massive fines and make U.S. government policy, he maintains, they must be called principal officers and be subject to appointment by the President and confirmation by the Senate.

Under Supreme Court precedent, Bader also contends, the SEC probably isn’t a “department,” and even if it were, only the chairman — and not, collectively, the five commissioners — could be called the commission’s head. In short, he says of the PCAOB, “I think they’re principal officers and need to be picked by the President.”

Harvey Pitt, who was SEC chairman when the PCAOB was established, disputes Bader’s notion that the accounting board is a federal department. The members of the board “aren’t high-level enough” for PCAOB to qualify as a department, he insists, adding that the President has many more important things on his agenda than regulating the public-accounting industry.

Pitt, now the chief executive officer of Washington-based consultancy Kalorama Partners, also advises the plaintiffs to “be careful what you wish for.” Should the lawsuit succeed, he observes, the PCAOB — which is funded primarily by assessments on public corporations — might be replaced by a taxpayer-financed federal agency. “I don’t think anybody in their right mind thinks that the PCAOB should be funded by general tax revenues,” he says.